This article was authored by Ross Allen, CFP®, EA, ATFA, Financial Planning Associate at Pathfinder.
It is the height of summer in the Cape Fear region and maybe the mere mention of “taxes” has you wanting to bury your head in a sandcastle. Tax “season” means different things to different people and tends to be one of those subjects that most people would rather not talk about after April 15th; but tax management is a year-long, life-long consideration. Unfortunately, many of us don’t realize this truth until we’re faced with an unexpected tax bill.
2020 forced many people into unexpected and unfamiliar work situations. Some workers lost jobs, many were suddenly working remotely, and others are still being impacted by the changes and challenges brought on by the pandemic. In response, the IRS enacted new tax legislation that was meant to help taxpayers who experienced hardships due to the pandemic.
Unfortunately, these laws sometimes ended in even more confusion and higher tax bills.
Let me share a story.
One of the situations we got involved with, and were able to correct, involved a premature 401(k) distribution of over $60,000. An individual took this distribution to help supplement living expenses after being advised to remain out of work due to medical treatments. Luckily, most of those funds were not needed, and they were able to return to work sooner than expected.
However, this person was now staring at a $20,000+ tax bill due to the huge increase in total income, which also raised them into a higher tax bracket. Not a pleasant surprise! Thankfully, we were able to intervene before the tax return was filed, and because of the IRS’ generous CARES Act in March 2020 most of the distribution was able to be returned to its rightful place in the 401(k), without any negative tax implications. Had this person not sought out help with their tax situation, they would not have known about the ability to re-deposit the money they had not used and would have been stuck with a huge tax bill and penalties. By asking the right questions, we helped them claim a tax refund (instead of them owing money when they filed), while allowing them to keep more of their hard-earned retirement savings in place with the potential to grow their retirement assets by more than $200,000, from now until they retire.
This situation highlights the importance of utilizing all of your available resources when it comes to taxes; having a team of professionals is not just for the ultra-wealthy any longer. At Pathfinder Wealth Consulting, a large part of our tax planning process involves coordinating with our clients’ CPAs. This is beneficial for all parties, as it allows us to uncover the nuances of your financial situation, while also making your CPA aware of any tax planning strategies we implemented throughout the year.
For example, one tax planning strategy we often consider is a Roth IRA conversion. This involves shifting a portion of a Traditional (pre-tax) IRA into a Roth (after-tax) IRA for the benefit of paying taxes now, at a lower tax rate, and having tax-free distributions later when tax rates are expected to be higher. This is a great strategy, and one that can be utilized over several years. There is only one problem: the 1099-R you receive for the IRA distribution doesn’t say the money went to a Roth IRA. It could be mistakenly reported as an “early distribution,” which could mean additional tax penalties that erase all the potential benefits of the Roth conversion. By sharing these details with your CPA, the distribution can be reported correctly and will ensure that you don’t pay more taxes than necessary now, and in the future.
As Benjamin Franklin said, “in this world, nothing is certain except death and taxes.” We would add another near certainty: tax laws will continue to change and are not likely to be simplified. This is why we review clients’ tax returns every year. We constantly look for new planning opportunities, including ways to reduce taxable income and total tax liability, to make sure our clients aren’t paying more than their fair share. We run tax projections throughout the year and monitor pending tax legislation to stay ahead of the impacts of tax law changes. And when (not if) new tax laws are passed we are ready to help guide you forward to avoid tax pitfalls.
Along with ongoing communication throughout the year, with our clients’ consent, we send consolidated year-end tax documents directly to their CPA which saves our clients time and energy, eliminates unnecessary paperwork, and makes life a little easier for their CPA!
Tax laws affect everyone but impact each person differently. The only way to fully understand the impact of taxes on your individual financial situation is to have someone work with you every year to develop an appropriate tax plan. Efficiently planning for taxes is just one part of the comprehensive financial plan we create and monitor for all of our clients. If you are interested in getting a second opinion on maximizing your tax situation, please visit our website or give us a call at 910-793-0616. We are here to guide you forward.
*Pathfinder Wealth Consulting does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.
Advisory services offered through Commonwealth Financial Network®, a Registered Investment Advisor.
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